No quick fix seen for long-running debt crisis

Policy differences, domestic politics slow progress

By

WilliamL. Watts

FRANKFURT (MarketWatch) — More firepower for Europe’s rescue fund appeared high on the agenda of euro-zone officials gathered in Washington over the weekend, but economists said deep divisions and fears of domestic political backlash will continue to complicate efforts to prevent a widely-expected Greek default from turning into a global financial catastrophe.

Weekend news reports said officials were working on a three-pronged plan that would recapitalize the region’s banks, use leverage to massively increase the resources of the 440 billion euro ($592.2 billion) European Financial Stability Facility, and facilitate a Greek default accompanied by a 50% haircut for bondholders, allowing the country to get its debt under control and remain in the currency union.

“If implemented, this ought to go some way towards stabilizing euro-area financial markets,” said Chris Scicluna, deputy head of economic research at Daiwa Capital Markets in London. “But, not least after the repeated failures of the past couple of years, serious doubts have to remain about whether euro-area countries will really deliver.”

The euro
EURUSD, -0.7836%
fell 0.4% to $1.3476 in choppy trade, while European equities gained ground. Fears of a worsening debt crisis have decimated European bank shares in recent weeks, dragging down equity markets around the world.

For many economists, vague talk of a wide-ranging plan to recapitalize the banks and shore up the rescue fund were undercut by signs key officials remain far apart on issues such as how to utilize leverage to boost the capacity of the EFSF.

German officials are seen as reluctant to push for additional changes to the EFSF as the Bundestag, the lower house of parliament, prepares for a closely-watched vote on earlier changes to the bailout fund approved at a July 21 meeting of euro-zone leaders.

German Chancellor Angela Merkel has been struggling to contain a rebellion against the plan by members of her ruling coalition. Merkel over the weekend said she remains confident she can win passage without having to rely on votes from opposition lawmakers.

“A significant number of opposing [lawmakers from within Merkel’s own coalition] will be perceived as a further blow to the fragile coalition. Clearly, at this stage the very last thing that the euro area can sustain is a political crisis in Germany,” wrote strategists at Lloyds Bank in London.

Merkel, Papandreou to meet

Merkel is set to meet with Greek Prime Minister George Papandreou in Berlin on Tuesday to discuss Greece’s ongoing efforts to meet the terms of the first rescue package and secure its next tranche of aid from the International Monetary Fund and European Union.

Meanwhile, all 17 euro-zone parliaments must approve the July changes, which were designed to give the EFSF more power to intervene in bond markets and provide lifelines to struggling sovereigns. But even with those changes, the EFSF is widely viewed as under-funded, leaving it incapable of providing a rescue for Spain or Italy if needed.

Slovenia’s parliament is set to vote Tuesday on the July 21 EFSF changes. The vote comes just ahead of the dissolution of parliament following the government’s fall earlier this month in a no-confidence vote.

Failure to approve the changes Tuesday could delay Slovenia’s ratification of the package until after a new government is elected in December, wrote analysts at RBC Capital Markets.

Finland’s parliament is also expected to vote this week.

European officials attending weekend annual meetings of the International Monetary Fund and World Bank in Washington found themselves under intense international pressure to prevent a situation that economists fear could echo the global financial crisis and recession that followed the 2008 collapse of Lehman Brothers.

U.S. Treasury Secretary Timothy Geithner urged European governments to team up with the European Central Bank to prevent a cycle of “cascading default, bank runs and catastrophic risks.”

Britain’s Daily Telegraph reported that the plan would see the EFSF provide a loss-bearing “equity” tranche for any bailout fund, with the ECB providing the rest in protected “debt.”

If the EFSF bore the first 20% of any losses, the fund’s capacity would amount to €2 trillion, the report said, citing unidentified sources. If the EFSF bore the first 40% of losses, the fund would be able to provide €1 trillion in buying power.

But Germany and the European Central Bank both appear reluctant to see the ECB play an even larger role in backstopping fiscal policy by euro member nations.

“This might not go down too well with the ECB which has faced internal opposition to its Securities Markets Program, and further uses of its funds could be seen to challenge its independence,” said Gary Jenkins, head of fixed income at Evolution Securities. “Anyhow, however they do it, at some stage the EU is going to have to move towards a fiscal union or implode.”

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